Tuesday, January 8, 2013

The two biggest reasons startups fail is running out of money and founding team implosions. One Y Combinator founder I spoke with felt that about ~20% of startups in his batch blew up in the first 9-12 months after entering YC due to founder issues.

When you find yourself in a situation where the working situation with your co-founder has degraded you need to decide:

A. Is this something you can work out? Every founder relationship has its problems. Can this one be fixed? Have you given feedback to your co-founder before? How did they react? Sometimes having a series of frank conversations is the best way to fix things.

Do not proceed to step (B) unless you have had a few frank, non-emotional conversations with your co-founder about the issues.

B.Who should leave? If this situation can not be worked out, which co-founder should leave? Should you resign? Or should one or more other founders be asked to leave?

The likely outcome to (B) depends on the relative leverage each person has. Who is essential to the continued life of the startup? How much equity does each person own? Who has a board seat and who does the board support?

If you are "equal founders" in terms of equity and board seats, you will need to have a series of frank conversations about how to separate If you have a strong lead investor, they may be invaluable in helping the you and your co-founder(s) work through this negotiation.

How To Fire Your Co-Founder

Here are potential steps to take if you need your co-founder step down:

Discuss the situation with your other co-founders, if any. Come to a consensus on letting the other founder go.

Discuss the situation with a handful of key stakeholders (e.g. your lead investors or advisor). You should be smart about what sort of conversation you have depending on your relationship with the person. Some investors you can ask for advice on the whole situation. Others you should only contact after you have taken action. A strong lead investor can help you negotiate with the founder you are firing and provide a fair outcome for both sides.

Determine what is fair.

What does your co-founder care about? Would they prefer to hold equity or cash?

How early in vesting are they? If the conversation is happening pre-cliff, one option is to let them keep the portion of equity they vested so far for time spent. [1]

If they have been part of the company for an extremely short amount of time, and they would be valuable in this role, you can convert them from a founder to an advisor with a much smaller, vesting, equity stake.

Alternatively, you can buy out their equity to date for some cash. If they are pre-cliff, then they have no shares for you to buy. In this case, you can focus instead on paying out a cash severance to reward their help in getting the company up and running. Consult with a lawyer on all your options and their implications [2].

The most extreme situation would be to wipe them from the cap table entirely with no compensation. If they are post-cliff, there are often clauses in the original stock agreements that if someone committed fraud or otherwise put the company at risk that they lose their shares automatically.

Board seats. If the founder is on the board, you usually want them to step down and make a clean break. You should think this through relative to (a) their relationship to you, the other team members and investors and (b) relative to the board dynamics you already have. Can you still fill the other common seat with someone else? This may be the de-facto outcome already written into your original company legal documents.[3]

Cash compensation / severance. You should decide how much salary to pay out as part of letting them go. This may depend in part on how much they are making per month, as well as the cash position of the company.

Figure out the situation with your lawyers. Have the paperwork for termination / non-solicitation / etc. ready before the conversation with your co-founder.

Prepare for key conversations. Write out the logic of why the founder is getting let go, what will happen to them (board seats, compensation, etc.) and when you plan to do it. You can use this as a guide for the conversations below.

Take swift action.

Meet with your co-founder and discuss that they are being let go. If you have communicated issues effectively with them up until this point, they should be well aware there are problems.

Communicate to various stakeholders.

Determine what to communicate. What is the agreed upon story you and your co-founder will share? If it is a contentious break up, there may not be a common story to tell.

Determine how to communicate to each of the following parties.

Your team (more below)

Investors or advisors.

You will want to call or tell some investors in person. Others can be notified via email as part of your regular company updates.

Partners or customers (if e.g. the co-founder was their main point of contact).

Press (only if needed). I know a large number of startups that are down a founder but the world at large has never noticed. While losing a co-founder can be very intense for you, don't project your emotions more broadly. Most people may never realize a change has happened.

Team communication.

Many employees may confuse losing a co-founder with a loss of belief in the startup itself. The co-founder may have hired a part of the team and be friends with them. Be proactive in addressing employee concerns in a straight forward manner. Bring in investors or advisors to show their ongoing belief in the company. If the co-founder is leaving on good terms (or had proactively resigned), you can potentially have them be part of the conversation or host a goodbye party for them that same week.

What To Do If You Are The Founder Asked To Leave

If you are the founder who has been asked to leave:

Try to remain rational. This is really hard emotionally and you will be upset. Stay calm and dig into the facts, the financial offer they are making you, and the true leverage they have over you. Is your firing a done deal that has full board approval, or posturing by your co-founder who has no real leverage? What is objectively best for the company?

Get a lawyer.

If it is a done deal, decide what you think is fair compensation-wise, and how to best communicate this back to the company.

Note: don't confuse the company's money with the founders' money. E.g. if they company raised a few hundred thousand dollars, you don't deserve "my share of it".

Determine which company stakeholders (investors, advisors) you want to reach out to over time in order to keep the relationship(s) intact. You don't need to do this immediately.

Don't worry about your reputation being hurt. Savvy investors see founding team issues all the time and understand early teams don't always survive the stress of a raw startup. You now have one startup beneath your belt and a lot of things you have learned for the next one.

Act in a mature and thoughtful way on the way out. Life is not a one act play.

Yes, you will be able to raise money again, hire people, etc. etc.

Don't dive back into things immediately. Take some time to clear your mind and get your emotions and life back in order before deciding what to do next.

Unfortunately, founder relationships, like marriages, often don't work out. The key to avoiding a break up is to make sure you and your co-founder are aligned up front. Keep communicating openly throughout the relationship as issues arise.

Some great founders have gotten fired in the past. Hopefully the above is helpful in navigating this painful and stressful change.

Notes
[1] If it is a contentious break up, you may not want them to own equity as they can cause trouble for you down the line. This is the reason to make sure you have vesting in place for everyone associated with the company, whether you raise convertible debt or equity. If co-founding a company is a marriage, the vesting is a pre-nup.
[2] I am very obviously not a lawyer, and can't give any legal advice.
[3] Another reason to read your legal docs and not just gloss over them!